Reviewed by Aug 27, 2020| Updated on
What is a Poison Pill?
The term poison pill refers to a defensive technique used by a target firm to avoid or deter an acquiring business from taking the risk of a hostile takeover. Prospective targets use this strategy to make the potential acquirer appear less appealing to them. Although not always the first — and best — way to protect a company, poison pills are usually very successful.
How Poison Pills Work
Throughout the corporate world, takeovers are relatively popular where one corporation attempts to take ownership of another. More giant corporations prefer to take on smaller ones because they want to reach a new market, when both firms combine competitive advantages, or when the acquirer wishes to reduce the rivalry. However, takeovers aren't always harmonious and become aggressive when the target isn't enjoying or willing to be taken over.
When a company is the object of a hostile takeover, it may use the tactic of poison pills to make itself less appealing to the prospective acquirer. As the name suggests, a poison pill is similar to something hard to take or accept. A company targeting an unwanted takeover may use a poison pill to unfavour the acquiring company or individual's shares.
The poison pill strategy has been used since the 1980s and was developed by Wachtell, Lipton, Rosen, and Katz, a New York-based law firm. The name derives from the poison pill spies brought in the past to prevent being challenged in the event their enemies captured them. It was designed as a way of preventing an acquiring company from buying a majority share in the potential target or negotiating directly with shareholders at a time when takeovers were becoming very common and frequent.